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Red Lobster owner Darden has bigger problems than activist investors

Passersby walk in front of the Times Square Red Lobster restaurant in New York, June 23, 2010. REUTERS/Keith Bedford

An investment firm with a large stake in Darden Restaurants (DRI), which owns Red Lobster and Olive Garden, has been saying for months it wants to fix the company, and now it's backing another idea: The board needs to think about replacing CEO Clarence Otis.

Barington Capital Group, which says it represents shareholders who have more than 2% of Orlando, Fla.-based Darden, argued in a letter it made public Wednesday that the company hasn't performed up to par under the current chief executive, who's been at his post for about nine years. Should Otis remain in charge, there's "little reason to believe that this will change anytime soon," the letter read.

"As the financial performance of Darden continues to decline, we believe that Mr. Otis is not only failing to pursue opportunities to create strong independent operating companies and unlock the value of Darden's significant real estate holdings, he is proceeding with a restructuring plan that could potentially destroy the opportunity to fully unlock this value in the future," Barington, which has also pushed for Otis to give up his chairman title, said.

The New York-based firm has stated repeatedly it disagrees with several aspects of Darden's operational approach, with one major component being the company's decision to examine options for parting ways with its Red Lobster unit. Barington has made clear it's interested in dividing the company, but not the way Darden has envisioned it. Instead of simply jettisoning Red Lobster, it has advocated the company form an operation to contain Olive Garden and Red Lobster, another for its smaller chains such as LongHorn Steakhouse, Capital Grille and Bahama Breeze, and potentially a real-estate focused business.

Along with Barington, shareholder Starboard Value, the owner of about 5.5% of Darden's stock, has been critical of the company's approach.

Reached for comment, a Darden representative said in an emailed statement that the company's "focus is on doing what is in the best interest of all Darden shareholders." The statement said the board is confident in the plans being taken "to deliver on this responsibility. We have been speaking directly with our shareholders and look forward to continuing that dialogue."

Trouble zone

Even if Barington gets its way, it's far from certain Darden's fortunes would reverse dramatically, considering some of the industry trends.

Last year, shares of Darden rose 20.6% after two consecutive down years. While that exceeded their average annual gain of 11.1% over the previous five years, it trailed the 54% advance of a broad group of restaurants tracked by Yahoo Finance and the roughly 30% increase in the S&P 500. Compared with similar companies — Barington specifically cites names such as Chili's owner Brinker International (EAT) and Romano's Macaroni Grill operator Ignite Restaurant Group (IRG) — Darden has also lagged in stock price. Those competitors were up an average of 34% in 2013 and 24.9% each year from 2008 through 2012.

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Darden stock vs. the S&P 500

Investors regularly cheer break-ups and their promise of setting free money ostensibly trapped within poorly functioning corporations. However, Darden isn't the only struggling restaurant manager. Though the vast majority of the group's stocks climbed last year, the handful of poor performances came from peers, with Ruby Tuesday (RT), Ignite and BJ's Restaurants (BJRI) missing the rally entirely. This year, Darden is down 6.5% vs. a slight gain for the restaurants overall. Following the release of the Barington letter, the stock edged up 0.2% to $50.81.

Darden inhabits a space where growth has been challenging to find and competition for customers extreme. As a recent report in Nation's Restaurant News notes, casual dining restaurants saw traffic fall 1% last year, based on NPD Group data. At mid-priced establishments, it was a 2% fall. Fast casual and fine dining restaurants, meanwhile, recorded gains. NPD analyst Bonnie Riggs said at the time the fast casuals, such as Chipotle (CMG), are claiming patrons at the expense of sit-down eateries. At the same time, these winners have elements in common with Darden's smaller chains. Hence, Barington's position on the split.

The chart below shows just how difficult it's been for Darden to get diners to its two biggest brands. This covers the past 28 months, back to November 2011.

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While a significant increase in one year can be reversed the next, accounting for a certain number of decreases, here, it's been pretty consistent weakness. In 20 of the months, same-store traffic has dropped at Olive Garden, and at Red Lobster, it's happened 21 times. The winter storms that struck the U.S. unquestionably factored into the past three months, and the company pointed out the impact, but the clientele has been staying away for considerably longer than that. Darden recently announced a new Olive Garden logo and menu alterations in hopes of rekindling interest in the Italian-themed venues.

If it's any consolation, here again, Darden's not alone. At Chili's, comparable-restaurant traffic has been negative 15 of the past 17 months. For DineEquity's (DIN) Applebee's division, traffic has declined for eight straight quarters. (Price increases, though small in general for the group, have been regular. That's been a positive offset for same-store sales, though it's likely kept at least some prospective visitors away as they watch their wallets.)

Darden says it expects this year's earnings to slide 15% to 20% from last year, with U.S. same-restaurant sales down 5.5% to 6.5% at Red Lobster and off 2.5% to 3.5% at Olive Garden.That outlook sums up the larger part of the story, which can get lost amid the machinery of Wall Street: The public isn't knocking down the doors of many well-known casual-dining establishments.

That doesn't mean Darden is merely a victim of picky eaters who've lost sight of its wonders. It's also not to say that, operationally, things won't improve if Darden breaks apart in some way. But pleasing shareholders in the near term is one thing. Getting folks back in the door is another.

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